Mgp Ingredients Inc Q2 FY2020 Earnings Call

Good day, and welcome to the Second Quarter 2020 Results Conference Call. All participants will be in listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Mike Houston with Lambert & Co. Please go ahead.

Thank you, Ian. Good morning, everyone, and thank you for joining the MGP Ingredients' conference call and webcast to discuss the company's financial results for the second quarter 2020. I'm Mike Houston with Lambert & Co., MGP's Investor Relations firm. And joining me today are members of their management team, including Dave Colo, President and Chief Executive Officer; and Brandon Gall, Vice President of Finance and Chief Financial Officer. We will begin the call with management's prepared remarks and then open the call up to questions. However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today, due to a number of factors, including the risk factors described in the company's most recent annual and quarterly reports filed with the Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release issued today, you can access it at the company's website, www.mgpingredients.com. At this time, I would like to turn the call over to MGP's President and Chief Executive Officer, Dave Colo. Dave?

Thank you, Mike, and thank you all for joining us. On this call, we will provide an overview of our results for the quarter, updates on key financial performance metrics and a discussion of progress against our strategy, then we will take your questions. Turning to the results for the second quarter. We remain encouraged by the demand for our products, the improved financial results as well as a strong balance sheet with ample liquidity to weather the challenges and uncertainty related to the COVID-19 pandemic. We saw improved results across most parts of our business this quarter, including the solid sales growth of aged whiskey, stronger sales for our white beverage and industrial alcohol products as well as solid gains in both revenue and gross profit for our Ingredient Solutions segment. Both of our business segments showed top line growth over the prior year, and as a result, our consolidated sales for the quarter increased more than 2%. On a separate note this quarter, MGP was the target of a cyber-attack that temporarily disrupted production at our assets and facilities. We have since resumed normal operations. And while there was no evidence that any sensitive or confidential data breach occurred, we take this issue and the integrity of our data and our systems very seriously and have since implemented a variety of measures to further enhance our cybersecurity protections and minimize the impact of any future attack. We estimate that the ransomware attack had a negative impact to gross profit of approximately $1.7 million, primarily as a result of a business interruption. The majority of the negative gross profit impact affected our Ingredient Solutions business segment during the quarter. We have insurance related to this event and are seeking to recover a portion, if not all, of any profit impact, including the profit associated with any loss of revenue resulting from this event. Looking at each segment individually. In our Distillery Products segment, sales finished the quarter up 1.6% to $75.2 million, while gross profit declined slightly to $16 million or 21.3% of segment sales. We are very pleased with the improved performance of our aged whiskey sales this quarter, representing strong double-digit revenue growth as compared to the prior year period from a diverse group of customers. This growth in aged whiskey reflects strong pricing, margins and demand. As we continue to provide structure to this unstructured market, it is clear that MGP has a unique competitive advantage. Our diverse aged whiskey library, along with a solid sales team and our ability to support our brand's growth regardless of its size offers a position of strength as we sell more aged whiskey in the future. Despite the uncertainty caused by the pandemic at the retail level and potential challenges to specific customers, we believe the underlying macro consumer trends supporting the ongoing growth of the American Whiskey category remains strong. These encouraging macro trends provide confidence as some new distillate customers work through elevated inventory levels during the quarter, reflecting a year-over-year decline in new distillate brown goods sales. Demand for industrial alcohol remained strong during the COVID-19 pandemic, as we continue to help customers navigate the challenges they are confronted with during these difficult times. Sales of industrial alcohol also increased for the quarter, up 11.2%, on increased volumes. While we have experienced increased demand related to COVID-19 over the past several weeks, it's important to point out that a significant portion of our industrial alcohol and premium beverage white goods production was already contracted for a set price last fall. Improved demand for industrial alcohol has come into play in the near term, but we do not view this pandemic as an opportunity to maximize short-term financial results on this product line. We believe the increased demand for our industrial alcohol products will continue throughout the balance of the year and into 2021. The increased production of industrial alcohol at our Kansas and Indiana facilities reflects our commitment to continuing the legacy MGP was founded upon more than 75 years ago as a supplier of industrial alcohol for the U.S. War effort. The increased sales of premium beverage white goods and industrial alcohol for the quarter had a dilutive impact on gross margins for the Distillery Products segment. Also of note, sales of dry distillers grains, or DDGs, increased 9.7%, primarily due to favorable average selling prices during the quarter as compared to the prior year period. The gains this quarter were primarily driven by decreased ethanol production across the ethanol industry, which reduced supply and drove DDG prices up over the short-term. As ethanol production comes back online, we expect to see increased DDG supply in the third quarter, and we anticipate selling prices to moderate throughout the back half of the year as a result. Revenue from warehouse services increased 5.8%, reflecting, in part, growth in the number of customer barrels aging in our whiskey warehouses and other services we provide. Turning to Ingredient Solutions; sales grew 5.4% to $17.4 million, while gross profit increased to $4.7 million or 27.1% of segment sales. This reflects a significant increase in gross profit margin as compared to the prior year period. We are pleased with the continued strength of our Ingredient Solutions segment this quarter and remain encouraged by the robust gross margins as a result of our ability to focus production and sales mix on our highest-margin products. Specialty wheat starch sales grew 26.5% this quarter, while our specialty wheat protein sales grew 14%, both primarily driven by increased volume. Our Arise specialty wheat protein and Fibersym specialty wheat starch product lines are well positioned within the baking, pasta and snacking categories to leverage the ongoing consumer desire to increase the amount of plant-based protein and dietary fiber in their diets as part of an overall healthier lifestyle. We feel very good about the robust project pipeline for these products as well as our recently rebranded ProTerra line of textured proteins and remain confident that they will drive long-term growth for this segment. Overall, both of our business segments continue to benefit from favorable consumer trends, and while we have maintained our position against providing 2020 financial guidance at this time, we remain confident in our long-term strategy. This concludes my initial remarks. Let me now turn things over to Brandon Gall for a review of the key metrics and numbers.

Thanks, Dave. For the quarter, consolidated sales increased 2.3% to $92.6 million, reflecting growth in both the Distillery Products and Ingredient Solutions segments. Consolidated gross profit increased 6% to $20.7 million as a result of increased gross profit in the Ingredient Solutions segment, partially offset by a $1.7 million impact of the cyber-attack that temporarily disrupted production at the Atchison facilities. Consolidated gross margin increased approximately 80 basis points to 22.4% of sales, up from 21.6% in the prior year quarter. Corporate selling, general and administrative expenses for the quarter were $9.4 million, up 8.3% versus prior year, due to higher personnel and incentive compensation costs, inclusive of certain incremental costs incurred related to the transition at the CEO position. We are focused on effectively managing SG&A, while still investing to grow. Consolidated operating income increased 4.3% to $11.3 million compared to $10.9 million during the prior year quarter, reflecting the increased gross profit in Ingredient Solutions segment, partially offset by decreased gross profit in the Distillery Products segment. Further offsetting the increase in operating income were the impacts from the aforementioned cyber-attack and increased corporate selling, general and administrative expenses. Non-GAAP operating income increased 11.5% to $12.1 million, exclusive of CEO transition costs. Our corporate effective tax rate was 23.1% in the current quarter compared to an effective tax rate of 25% in the prior year quarter. Net income for the second quarter increased 7.3% to $8.5 million, and earnings per share increased $0.04 per share to $0.50. Non-GAAP EPS increased to $0.54 per share from $0.46 per share in the second quarter of 2019. These increases from prior year are primarily due to improved operating results. We discussed the strong fundamental cash-generating capability of our business, which allows us to provide positive operating cash flows even as we invest in other parts of the business. Year-to-date cash provided by operations totaled $6 million. Accounts receivable and days sales outstanding experienced a slight increase of $1.7 million in five days during the quarter, respectively. This increase is consistent with the development of new long-term supply agreements with large customers. The increase is also a result of continued consolidation of smaller prepay customers by larger national and multinational customers with payment terms. Because we are selective in the customers we extend credit to, they are mostly large in nature and all have a combination of strong balance sheets and long payment histories with MGP. As a result, we're not experiencing issues with collections. During the period, we also invested a net $1.7 million in our barrel distillate inventory for aging. Despite the uncertainty related to the pandemic, we believe our library of various mash bills and vintages will continue to contribute strong levels of profit for the company going forward. It's important to note that past or even recent quarters are not necessarily indicative of barrel distillate investment in subsequent quarters. Fluctuations in our quarterly investment can be impacted by a number of factors, including customer demand for new distillate, production efficiencies, mixing capacity, warehouse capacity and sales of aging whiskey. Our balance sheet and access to capital continue to be strong, while we continue to optimize cash management during this pandemic. We remain well capitalized and paid down approximately $30 million on our revolving credit facility during the quarter, while also maintaining a conservative cash position. We remain confident that we have sufficient liquidity in the event of the pandemic directly impacting operations. As such, we ended the quarter with a debt balance of $66 million and a cash balance of $11.7 million. As of June 30, approximately $275 million remain available under the $300 million revolving credit line. Our leverage continues to be very low, and we haven't experienced any significant economic hardship on our business to date as a result of the COVID-19 pandemic. Recently, the Board authorized a second quarter dividend in the amount of $0.12 per share, which is payable on September 4 to stockholders of record as of August 21. This marks the tenth consecutive year that MGP has paid a dividend. The Board continues to view dividends as an important way to share the success of the company with shareholders.

Thanks, Brandon. Now, I would like to touch on some additional initiatives that support our long-term strategic plan. The headwinds we identified last quarter have persisted with varying impacts on our financial results. During the quarter, the first headwind related to the initial pantry loading that had occurred during the first several weeks of the pandemic, which caused off-premise sales to significantly spike. While these elevated growth comparisons began to taper in the back half of the second quarter, the demand for distilled spirits, including American Whiskey, remains strong. We are unsure how long these purchasing behaviors will continue and what potential impact they might have on future off-premise sales. We believe the spike in off-premise sales during the pandemic has partially offset declines in on-premise sales across the nation. As more bars, restaurants and tasting rooms reopen, we expect the off-premise sales to normalize over time. As you would imagine, the closures of bars, restaurants and tasting rooms had an immediate impact on our craft customer sales the past few months, even though, some states implemented phased reopening plans. We would anticipate these trends to improve as these establishments reopen, but it is difficult to predict when that might occur in a meaningful way. Third, we began to see some of our multinational customers conserve cash this quarter, which had an impact on new distillate sales results. While most have strong balance sheets and access to capital, it is unclear how the conservation of cash may introduce additional quarterly sales volatility, which could impact our brown goods sales throughout the balance of the year. Lastly, international export sales did not meet pre-pandemic expectations as travel has been dramatically reduced and tariffs in key international markets persist. We continue to believe that our investments to expand international sales will provide long-term shareholder value. We continue to closely monitor each of these potential headwinds, and we'll provide additional updates on future calls. Despite the continued uncertainty surrounding the COVID-19 virus and the diminished visibility of a possible macroeconomic recovery in the back half of the year, I am very pleased with the continued execution of our pandemic response plan, which focuses on protecting our employees and doing our part to help stop the spread of the virus. The investment spend related to our warehouse expansion plan was substantially completed during the quarter and totaled approximately $49.8 million. We anticipate additional investments in warehouse capacity to continue over time as needed to support the growth of our customers. Additionally, our investment in aged whiskey inventory grew slightly to $113.1 million at cost as we reduced our incremental investment in aged whiskey inventory during the quarter versus prior quarters. As we've previously stated, our growth in sales of brown goods over the past several years has outpaced the broader market, this was due in part to the subset of the market we serve, growing faster than the overall market. While the consumer trends for American Whiskey remain robust, we now believe that the underlying growth rate for our target market is gradually slowing to come more in line with the long-term trend for the overall category. As a result, we plan to reduce our overall aged whiskey inventory levels over the balance of the year, as we believe we have adequate inventory to meet both our customers' and our own needs. We continuously evaluate our aged whiskey inventory levels, and we'll make adjustments to these levels to support demand as needed. In addition, we believe the continued strength of the American Whiskey category through this pandemic has confirmed the long-term value of our aged whiskey inventory. Furthermore, we are continuing to assess M&A opportunities to strengthen our position in growing markets in concert with our financial position in the coming quarters. Turning now to our brands. We were pleased to announce the release of Remus Repeal Reserve Series IV Straight Bourbon Whiskey in September 2020. Now in its fourth year, our Remus Repeal Reserve Program has exceeded expectations, and this early fall release allows us to showcase the brand during National Bourbon Month in September. Our George Remus Bourbon and Rossville Union Rye Single Barrel programs, which were launched in the first quarter of this year, were in high demand as pre-sales exceeded our expectations. Offered only once a year, MGP is in a unique position to provide a variety of mash bills to our trade partners, and we're proud to age some of the finest whiskey barrels in the country at our Lawrenceburg facility. The addition of Green Hat Gin to our award-winning brand portfolio continues to progress despite on-premise closures due to the pandemic. To mitigate the effects of on-premise closures, we have leveraged social media and virtual tastings to keep each of our brands front and center for consumers. Our premium beverage brands were not immune to the decreased on-premise activity this quarter, while sales activity has increased in states that have undergone partial reopenings, uncertainty persists as states determine how and when full reopenings of bars, restaurants and tasting rooms will occur. However, we will continue to invest in our brands portfolio as we consider this initiative an important driver of long-term growth. We were also proud to support the industry and our communities that have been hardest hit during these difficult times with donations to the United States Bartenders' Guild, the Restaurant Workers Community Foundation, Emergency Relief Fund and the World Central Kitchen. Before we open the call up for questions, I would like to reiterate our continued confidence that focusing on our key strategies will drive superior long-term shareholder value. Both of our business segments continue to be well positioned against strong macro consumer trends, and we continue to believe that our strategy will drive long-term sustainable growth. Operator, we are now ready to begin the question-and-answer portion of the call.

Our first question comes from Donald McLee of Berenberg.

So just to kick things off, I wonder if you could talk a bit about some of the product characteristics that differentiate the specialty ingredients products from the commodity products. And what markets they ultimately serve?

Yes, sure. Let's start with the markets. We primarily sell into baked goods, pasta, and snacking categories. Regarding product lines, let's begin with specialty starch, particularly Fibersym. This product enables formulators to introduce fiber, which results in a lower net carb count for the finished product. Additionally, since it's a wheat-based fiber, it blends very well with other wheat-based proteins like Arise. This combination provides the advantages of high fiber and high protein, leading to reduced net carbs. Both product lines align with current trends as consumers seek to boost their protein and fiber intake while cutting down on carbs. These are the main factors driving the increased demand for these two specific product lines.

Okay, that's really helpful. And then switching to your CapEx guidance. So first question, could you talk a bit about the pacing of that $20 million or so of CapEx in the back half of the year? And then as a follow-up, how much of that CapEx is maintenance versus expansion?

Yes. Welcome to the call, Donald. This is Brandon. I'll take that one. So we are still guiding full year CapEx to be $19.6 million. So year-to-date, that number is coming in right around at $6 million. So you can expect the lion's share of that $19.6 million to come in the back half. Our projects do range between maintenance and growth as well as environmental-type projects and safety. So beyond that, we don't give further breakdown in detail as to how much in each bucket, but just know that we are always looking for ways to invest capital to better position our company within the industries we serve.

Could you provide some insight on how the U.S. spirits market share has trended year-to-date within the overall beverage alcohol category amid the disruption of COVID-19?

Yes. I think that what the trends have been playing out during COVID is the off-premise sales have been up significantly versus prior year. Early in the pandemic, let's call it, the first two months, spirits, in particular, were trending up 30-plus percent in the last few weeks as some partial reopenings have occurred in on-premise. Off-premise spirit sales are continuing to be up about 20%. So overall, with on-premise being off substantially, off-premise up, it's almost a net position for growth in the overall spirits category year-to-date.

Our next question comes from Bill Chappell of SunTrust.

The rapid fire, just kind of going around on a few issues. I guess, one, on the new distillate sales in the quarter that were hit by customer shutdowns or just delays, have you seen any of that come back? Has it got any worse as you went through the quarter? Have you had any indications from the customers as to whether they will come back?

Yes, Bill, I believe there were two main factors that impacted the quarter. First, customers are being conservative with their cash due to the uncertainty caused by COVID, which was a significant influence. Additionally, some customers were using up existing inventory during the quarter. Looking ahead, I expect that as long as COVID remains a concern, it will continue to lead customers to be cautious with their cash. If market demand remains relatively stable, with on-premise sales offsetting off-premise gains, it will likely take time for them to deplete their inventories. However, in the long run, we are still optimistic about new distillate sales.

Is there any way to quantify what the impact was in the quarter for that?

Yes. We mentioned that new distillate sales volumes decreased, while aged products experienced strong double-digit growth in percentage terms. It's also important to note that even though total brown sales fell by 7.5%, total gross profit and gross margins for brown products increased. This quarter serves as a good example of how our diversification within the brown product category is helping us meet customer needs in the current shifting environment.

Got it. And then switching over to the aged side. That's great that things are continuing to be in a positive momentum there. But I guess, Dave, on your comment that you want to meaningfully get down the aged inventory on the balance sheet, which is probably, I guess, about $113 million. That would imply you have a home or a potential home for some of this inventory in the back half of the year. Otherwise, I guess, it would just continue and hopefully at reasonable prices. So can you maybe talk about that? And what your visibility is into getting the inventory level down?

Yes. I think as we spoke about this, I think at the inventory levels we're at now, we feel pretty good that we've got adequate vintages, if you will, and different mash bills to support the demand that we see in the near term for both our customers as well as our own internal use. So I think it will be a combination of the demand for the product that will bring the inventory levels down as well as our put-away scaling that back a bit. So those two factors, I think, will contribute to the decline in the overall value of our aged whiskey.

So, is it safe to say that you feel comfortable that you can place it in the back half despite customers being a little tighter with their cash?

Yes. I think we saw a pretty good demand here in Q2. And as far as what we're seeing going forward, I'd say with the craft distillers, we did see softness in Q2. As some of the partial reopenings start to occur, that has a positive benefit on the craft players. So we're hopeful that we'll see some improvement in demand with craft and then ongoing demand with the national and multinational customers. And then, of course, as things open up internationally, we would hope that our export sales opportunities come to light as well.

Got it. And then, switching to industrial alcohol; I mean, I know things have contracted out, you're running at 100% utilization, but volumes seem to pick up sequentially, implying that you found a little more capacity. Is that a good number to kind of use for the remainder of the year in terms of extra volume? Or can you find even more from here?

Yes. What we're aiming to do is fulfill our contractual volume obligations with key customers, and as we discussed in the last call, those long-term customers have also presented some additional demand. Therefore, we're also focused on accommodating this increased demand as much as we can. We are fully booked for the remainder of the year, and our priority is to meet those contractual commitments throughout the year.

But it sounds like you're finding some excess capacity. Is that fair?

Yes, I believe the distilleries are operating very efficiently, and as a result, we've been able to increase our capacity.

And do you still think you can get some pricing potential as we move into 2021, if demand remains as strong?

Yes. I think that's definitely the pattern that we're seeing. We anticipate that, obviously, the demand is staying strong for the balance of this year. Based on what we know now, we think that the demand will stay elevated as we go into 2021. And we are seeing prices reflect that as we're coming into the new contracting season here in the back half of the year.

Great. On Ingredient Solutions, you mentioned focusing more on the higher profit items. Can we expect that profits for this division will grow faster than sales for the next few quarters?

Yes. I think the team has done a really good job on selling the specialty wheat proteins and starches and minimizing the commodity products. So that if that trend continues, then your statement is fairly accurate that that should be what kind of plays out here in the back half.

And our next question comes from Alex Fuhrman of Craig-Hallum Capital Group.

I wanted to follow-up on the plan to reduce your aged inventory levels. I mean, obviously, it was never the plan to grow those forever. But it sounds like just from your commentary on the call that maybe there's a little bit of extra motivation to reduce those levels than we've seen earlier in the year. So can you talk about maybe some of the trends you're seeing about the category, perhaps starting to normalize that have caused you to reach the determination that you want to start to be reducing your aged inventory levels? And then, just bigger picture. I imagine you still want to be having a portfolio of aged whiskey as part of your library and your business. Is there a certain kind of dollar level we should be thinking about that as kind of a minimum level that you need to have in order to be a significant player in that space and have a good assortment of mash bills and vintages?

Yes, great questions. The reason we're starting to scale back on aged inventory is that, as mentioned earlier, while we were stockpiling products five to six years ago, the growth in the customer segments we targeted was strong, but now we’re seeing that trend slow and align more with overall category growth. That's the main reason for our decision to reduce inventory levels. We will continue to set aside whiskey each year to ensure we have the right vintages and mash bills to meet our customers' needs moving forward. However, given that we've accumulated a significant amount of whiskey, we're essentially normalizing our inventory levels based on current insights.

Okay, that makes sense. And then if I could also just ask on the cyber-attack. I think you mentioned the impact to gross profit on the quarter was $1.7 million. Can you just walk us through the specifics of that number? I mean, is that lost sales? Is that increased production cost or having to move inventory around? And should we expect that to kind of come back in the back half of the year? Just any color on how we could think about that from a modeling perspective? That would be helpful.

Yes, good question, Alex. This is Brandon. As Dave mentioned earlier, the majority of the $1.7 million affected the Ingredient Solutions business. You are correct that it was largely, if not entirely, due to business interruption, which included reduced sales. We are currently in the process of addressing this situation, and since we have insurance for this type of event, we are working to recover some, if not all, of that $1.7 million. We are optimistic about receiving reimbursement by the end of the year, and potentially even within the third quarter.

Our next question comes from Ben Klieve of National Securities Corp.

First, just a couple of follow-on questions regarding the cyber-attack. First, sorry to hear about that. How long was production shutdown as a result of that?

Yes, we didn't share that information to avoid disrupting our business and affecting customer orders, as indicated by the $1.7 million gap we identified. However, we are operational and have made several positive adjustments in our remediation efforts. We ended the quarter in strong condition, unaffected by the impact.

Okay. It seems you might have already addressed my next question. So, as of July 1, the past impact is behind us, and the third quarter should not be affected by that, is that correct?

That's exactly right.

Okay, perfect. I have one more question for you. As you consider the possibilities for mergers and acquisitions, Dave, now that you've been in your role for nearly a full quarter, how do you view M&A in the branded spirit market, particularly given the current global circumstances and their effects on the food service industry? Additionally, how has your perspective on this evolved over the last few months, and what are your expectations for M&A activity in the coming quarters?

Yes. We still view branded spirit as a great space, long-term. There is some choppiness in the short-term, obviously, in just about every food and beverage category due to the pandemic. But I think the way we look at M&A is much more long-term and what do we think the long-term trends are going to be, and that's what gives us confidence that as we evaluate M&A, and particularly M&A in branded spirits, we do think that's an excellent category to participate in over the longer term. So it doesn't really deter us, per se, based on the current conditions. And so we continue to actively look at potential opportunities and feel it will be a great addition overall to the company if we can be successful.

This concludes our question-and-answer session. At this time, I would like to turn the conference back over to David Colo for any closing remarks. Please go ahead.

Thank you for your interest in our company and for joining us today for our second quarter call. We continue to make progress toward implementing our strategic plan and remain confident that it will provide us the resources we need to deliver long-term sustainable growth. We look forward to talking with you again after the third quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.